Wednesday, March 14, 2012

How would you feel if you worked for a state or local government for 20 or 30 years only to have your pension slashed dramatically or taken away entirely? Well, this exact scenario is playing out from coast to coast and in the years ahead millions of elderly Americans are going to be affected by broken promises and vanishing pensions. In the old days, things were much different. You would get hired by a big company or a government institution and you knew that the retirement benefits that they were promising you would be there when you retired in a few decades. Unfortunately, we have now arrived at a time when government institutions and big companies have promised far more than they are able to deliver, and "pension reform" has become one of the hot button issues all over the nation. Many Americans that have been basing their financial futures on their pensions are waking up one day and finding that their pensions are either gone or have been cut back dramatically. According to Northwestern University Professor John Rauh, the latest estimate of the total amount of unfunded pension and healthcare obligations for state and local governments across the United States is 4.4 trillion dollars. America is continually becoming a poorer nation and all of that money is simply not going to magically materialize somehow. So where is that 4.4 trillion dollars going to come from? Well, either pension benefits are going to have to be cut a lot more all over America or taxes will need to be raised dramatically. Either way, we are all going to feel the pain of these broken promises.

There simply is not enough money out there to keep all of the pension commitments that have been made. Something has got to give. In the end, millions of elderly Americans will likely be plunged into poverty as pensions disappear.

Some local governments around the nation are already declaring bankruptcy and are either eliminating pensions or are cutting them very deeply. Just check out what just happened in Central Falls, Rhode Island.... (more)

They may not have access to the armed forces but it is often argued that the chairman of the Federal Reserve has a level of global power and influence that rivals that of the U.S. president. While most investors know the name of the current Fed chief, Ben Bernanke, how his decision-making impacts your money is much more elusive. In this installment of Investing 101, we address how the Federal Reserve's policy-making decisions impact your investments in stocks, bonds, and commodities.

1. Fed Liquidity & Stocks

The role of the Fed is simple on paper. The entity exists to carry out a dual mandate to use monetary policy to promote maximum employment and stable prices (keep inflation in check). That's it. While many critics believe the 2008 financial crisis caused the Bernanke Fed to stray beyond their traditional mandate, the debate is best left to the scholars.

What you need to know is whether the Fed is lowering interest rates or adding money or taking other actions that support or nurture economic growth --generally referred to as an "easing cycle."

"When the Fed is adding liquidity into the system, it's good for stocks," says Doug Roberts, author of Follow the Fed to Investment Success. "If they're not injecting liquidity (which is called ''tightening") and there's a crisis where the economic system is contracting, it's bad for stocks."

But it's not as simple as higher rates versus lower rates.

"I think you have to really look at what the Fed is doing," says Roberts. "If you rely on what they're saying, it's sometimes confusing."

The Fed holds eight regularly scheduled meetings per year, and it seems each one captivates Wall Street's attention. Investors go to great lengths to detect any hints that the Fed might be changing its policy direction and economic outlook.

2. Interest Rates & Bond Yields

Like stocks, your bonds are also impacted by rising and falling interest rates or other actions of easing and tightening by the Fed. Simply put, if the Fed is easing, or cutting interest rates, the value of your bonds will typically go up. But, if rates go are going higher, the value of your bonds that pay a lower percentage rate, will go down.

At the same time, you must remember the second part of the Fed mandate --price stability/inflation. Be aware that a rate hike is the surest method known to slow inflation, but there's a catch.

"Bonds can do well when the rate of inflation is higher than short-term borrowing costs," Roberts says, but points out when that it occurs, it's typically a good time to own gold.

Outside of its interest rate policy which has kept rates near zero for the last three years, the Federal Reserve is currently deeply involved in the bond market by directly purchasing bonds. These unprecedented actions, done under the banner of quantitative easing (or "QE" for short), have had an enormous effect on the marketplace, no different than if an extremely wealthy investor were suddenly buying up houses, lumber or gold.

3) The Fed's Impact on Gold & Commodities

Speaking of gold, the precious metal's role as an investment that can protect you from inflation is just part of the reason that it is effected by the words and actions of the Federal Reserve. Because the dollar is directly linked to the rise and fall of rates, Roberts says ''depreciation of the currency" has as much, if not more, impact on commodity prices.

Therefore, falling rates and a falling dollar tend to increase the appeal and price of gold, oil and other commodities.

"These assets by nature, are volatile even in goods times, so you have to be prepared," Roberts cautions, reiterating the need to pay attention and be aware of how the Fed's easing and tightening impacts virtually all asset classes.

In the Spring of 2011, when Libyan oil production -- over 1 million barrels a day (mpd) -- was suddenly taken offline, the world received its first real-time test of the global pricing system for oil since the crash lows of 2009.

Oil prices, already at the $85 level for WTIC, bolted above $100, and eventually hit a high near $115 over the following two months.

More importantly, however, is that -- save for a brief eight week period in the autumn -- oil prices have stubbornly remained over the $85 pre-Libya level ever since. Even as the debt crisis in Europe has flared.

As usual, the mainstream view on the world’s ability to make up for the loss has been wrong. How could the removal of “only” 1.3% of total global production affect the oil price in any prolonged way?, was the universal view of “experts.”

Answering that question requires that we modernize, effectively, our understanding of how oil's numerous price discovery mechanisms now operate. The past decade has seen a number of enormous shifts, not only in supply and demand, but in market perceptions about spare capacity. All these were very much at play last year.

And, they are at play right now as oil prices rise once again as the global economy tries to strengthen. (more)

Nominal prices are arguably not the best way of looking at things. I asked Doug Short at Advisor Perspectives if he would chart "Real" home prices. His answer was "In a heartbeat, if I can get the data".

After receiving an Excel spreadsheet of the HPI data from LPI, I passed the spreadsheet on to Doug Short. I suspect he did not know what he was getting into, because once I supplied the data, I started asking for all kinds of charts.

I asked Doug for help for the simple reason his charts and the charts by Calculated Risk are in a class of their own. Advisor Perspectives frequently uses my articles so I went that route.

Note that "Inflation Adjusted" itself can mean many things, and indeed this post will take a look at "Real" home prices from several angles.

The two most common ways to adjust for price inflation are the CPI (consumer price index) and the PCE (personal consumption expenditures index). We use the CPI in the rest of the charts below because individual components' percentage weights are readily available. (more)

SPDR Gold Shares (NYSE:GLD) — This exchange-traded fund (ETF) seeks to replicate the price of gold bullion, net of expenses, and is most accurate in its pricing to gold since it is the only ETF that holds physical gold.

GLD rose from around $120 to over $188 last year, but since the double-top of August/September, the trend has flattened with support at about $150 and resistance at $175. However, a closer examination of the trading pattern reveals a reverse head-and-shoulders with the neckline at $175.

Pullbacks have been supported at the 200-day moving average where GLD is now. The stochastic flashed a buy signal last week, and if the neckline is broken, the target for GLD would be $200.

China may be sitting on world's highest foreign exchange reserves of about USD 3.20 trillion but it is also burdened with USD 2.78 trillion government debt causing great deal of concern among policy makers.

China's government debt amounts to about 17.5 trillion yuan (USD 2.78 trillion) about 43 per cent of the country's gross domestic product ( GDP), Yang Kaisheng, president of the Industrial and Commercial Bank of China, said today.

It is composed of 10.7 trillion yuan (USD 1.7 trillion) of local government debt and 6.8 trillion yuan of central government debt, Yang told a press conference on the sidelines of China's annual parliamentary session.

As the concerns over the debt mount, China's Bank regulator has said that the government will take steps to guard against possible defaults which could cause extensive damage to the financial stability of the country's banks.

China will boost the clean-up of thousands of millions of local government's debt in 2012, so as to guard against the possible defaults that would hurt its banks, China Banking Regulatory Commission (CBRC) said on March 2.

To start with efforts will be made to focus on cleaning up old loans made to local government financing vehicles (LGFV) while tightening new debt issues and raising cash to debt coverage ratios, it said.

The CBRC will strictly control the use of LGFV loans, while giving priority to key projects that are under construction, it said.

The regulator will also improve risk monitoring and reclassify LGFV loans to relieve pressure from banks.

Analysts said any default of a certain proportion of the loans will push up non-performing loan ratios in the banking industry and threaten banks' credit ratings.

The concerns over the rising local debt prompted Chinese PremierWen Jiabao to state last month that his government has taken the issue seriously.

"Currently our government debts are in an overall safe and controllable level," Wen said.

Besides the local debt, China's foreign debt has increased to USD 697.16 billion at the end of September, up from USD 548.9 billion in 2010.

Officials maintain that the debt is manageable as China is backed by USD 3.20 trillion forex reserves.

I like to term the VIX or the CBOE Volatility Index, the Complacency Index, because it is an excellent gauge of whether or not traders are complacent or fearful. The higher the reading, the more fearful or worried they have become. The lower this index reads, the more complacent or careless they generally are.

One has to go back a period of 45 MONTHS (June 2007) to find investor psychology at these levels of complacency in regards to the broad stock market as indicated by the S&P 500. I should point out that this was one year prior to the credit meltdown of the summer of 2008. It would currently seem that hardly anyone on the planet is the least bit concerned about the level of the US equity markets due to the enormous amounts of Central Bank supplied liquidity.

I intend to keep posting this index at regular periods to keep an eye on this as I believe investors are growing very careless in regards to the potential for an apple cart upsetting event.

Something about this just does not "feel" right to me. While one cannot argue with the tape, or in this case, the charts, the fact that all of the woes tied to the enormous amounts of indebtedness in the West have essentially been papered over, is extremely disconcerting.

The "Chart of the Day" is Alexion Pharmaceuticals (ALXN), which showed up on Monday's Barchart "All Time High" list. Alexion on Monday posted a new all-time high of $88.50 and closed up +3.71%. TrendSpotter has been Long since Dec 20 at $68.99. In recent news on the stock, Goldman Sachs on March 2 reiterated Alexion as a Conviction Buy based on the company's high growth potential, attractive drug portfolio, and status as a potential M&A buyout candidate. UBS on Feb 23 upgraded Alexion to a Buy from Neutral and raised the target to $99 from $73. Alexion Pharmaceuticals, with a market cap of $14 billion, develops pharmaceutical products for the treatment of heart disease, and inflammation, diseases of the immune system and cancer in humans.

After the last 12 months of craziness traders can be forgiven if they've become inured to moves in precious metals. To those who swore off semi-precious silver last summer it's time to rue the day: Silver has rather quietly staged a more than 20% rally since the beginning of 2012.

According to Michael Purves, chief market strategist at BGC Financial, silver is apt to warrant more attention. "Silver is a poor man's gold and it's also very volatile," he says. "I think a lot of that volatility will be skewed to the upside".

And by "upside," he means a move to all time nominal highs. The semi-precious is "setting up for something more powerful; we could see $50 later this year," he states.

To support his case Purves notes the encouraging price action since last May when silver pushed that same $50 level before collapsing hideously. The bright side of that sell-off is that silver never returned to whence it came before going parabolic at about $19. A true bubble would have taken back all the gains; silver may still do so but at least for now it remains almost 70% higher than it was in September of 2010.

The drivers for a move higher are silver's status as a hard money and industrial demand. In a world of systemic currency abuse and slow yet positive growth, silver wins, at least as Purves sees it.

For those more equity inclined Purves suggests looking into the gold and silver miners. Since the stock market bottom made three years ago last week, the Market Vectors Gold Miners ETF (GDX) has gained about 60%. That's a terrific gain unless its compared to the S&P 500's 100% gain or the 150% move in silver itself.

"It's only a matter of time" until that performance spread tightens says Purves, noting the positive technicals and tight range in which the GDX has traded. The fact that the same could be said of many things and most of them are unpleasant doesn't dissuade Purves. He likes the miners and is willing to wait, provided he can do so while holding silver.